My February column (Negotiating a purchase) dealt with acquisition as a growth strategy for existing businesses, or as an entrepreneurial bridge into self-employment.
Of course, that strategy requires capital. Starting from scratch, you might be able to bootstrap a startup by leveraging your personal resources. But that usually isnt an option when buying a going enterprise.
Its difficult to grow without credit. So what can you do, given that banks have zipped up their lending in response to the credit crisis? If you already are in business with a line of credit, its probably been reduced for little or no reason.
With an economy still not producing any real job growth, one would expect more help for smaller businesses. It is simply amazing to watch politicians laude small business as the chief engine for job growth while ignoring the barrier a lack of capital poses in creating that growth.
According to the Ewing Kauffman Entrepreneurial Foundation which focuses on research and policy in the entrepreneurial segment six to 12 percent of all new employment comes from raw startup companies. The foundation also concluded employment gains at both new and expanding businesses represent 16.4 percent of total private sector employment growth. We need these entrepreneurial entities and the growth potential they represent to move our national unemployment numbers downward.
With the huge growth of federal spending, higher taxes are sure to follow along with the inflation that financing that deficit. This already is causing the precipitous decline in the value of the dollar against foreign currencies. While that is beneficial for large manufacturing firms that do a lot of export business, not many smaller businesses have the ability to export.
As inflation rises, so do small business day-to-day operating expenses. The U.S. Small Business Administrations Office of Advocacy recently reported businesses with fewer than 50 employees pay 35 percent more for electricity than their industry averages while large firms with more than 1,000 employees pay 17 percent less than the average. That is a huge differential. Of course, the cost disparity between large and small business also stands out for even the simplest purchases of raw material and supplies. Limited purchasing power impacts the greatest in times like these. Every small business customer is trying to save money making it difficult to pass along price increases. So margins are squeezed, further reducing cash flows.
Even if you have the ability to assume more debt, think carefully about it. I know no small business borrower not required to pay a floating interest rate on a commercial loan, as well as personally guaranteeing it. With higher taxes, inflation and interest rates likely ahead, this may not be the right time to borrow money, regardless of your businesses condition.
Use every tactic you know for conserving cash flow. For example, increase your inventory of goods likely to rise in price; renegotiate contracts before higher prices hit; explore buying groups in your industry that could help you secure lower prices on key items.
Does all this mean you should forego an acquisition? Absolutely not, but you need to approach it with a great deal of caution. First, for reasons already given, you likely should not use leverage to buy anything. Put on your creativity hat to bring a deal to conclusion. Studying a potential target can pay huge dividends in the end. Here are some considerations:
Ensure the acquisition is complementary to your business, and offers synergies.
Make sure the business is well run and profitable so there will be no cash drain after purchase.
Take time to get to know the owner and understand the reason he/she may wish to sell. Make sure key employees are willing to stay.
Request the current owner stay on to assist in the transition.
Finally and most importantly, insist the owner finance the purchase. It might be wise to offer a long-term consulting contract as a further incentive. You also can offer a bonus for above average performance of the company over the length of the note. Be sure to negotiate a fixed rate of interest and offer a down payment no larger than you can afford out of pocket. Remember, the price in this situation is almost irrelevant if you can control the deal structure. If you can control the structure, and the owner is willing to finance, you can afford to pay a little more.
Finally, always craft a win/win agreement.
With cautious and intelligent due diligence, these times are really worth the effort to identify businesses to purchase. Take the time to structure the deal with the least cash possible, without applying more than minimal leverage.